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Capital Markets

Credit's quiet revolution

The development of instruments that match investors' views on defaults, recovery rates and correlations with leverage and return targets represents a fundamental change in fixed-income investing. However, to take advantage of these opportunities, investors need new infrastructure and new risk-management skills.



Peter Lee, Euromoney  Let's start by asking why investors – particularly those in Europe who are newer to structured credit –  should consider investing in this asset class?

Paul Czekalowski, UBS  In a word optimization. Credit structuring means liquefying credit – identifying sources of credit risk and then transforming that risk's form or characteristics. This forces you to ask more broadly: what is credit? A promise to pay? What kind of assets or contracts involve a promise to pay? Defined like that, "credit" can be insurance contracts, receivables, secondary insurance, reinsurance; it can be all sorts of counterparty risks and contract risks. Obviously only a small proportion of those are currently tradable, so the structured credit market uses a range of tools and techniques for juggling that risk around, rating it and distributing it in formats tailored to a variety of investor bases. Until recently, this type of optimization primarily meant slicing up credit risk and repackaging it within a collateralized debt obligation (CDO); but my group is now just as concerned with other forms of optimization – tax and accounting, for example.

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